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I agree with the concept that the Paulson plan involves "overpaying" for the assets. Currently, the market for any mortgage backed security is distressed even if it is 100% performing. I've heard that performing "normal" mortgages are selling for 45 to 65 cents on the dollar. Subprime, even if performing, is under 35 cents. The plan is to buy some of these which creates the value nearer to $1 which can than be used to reflate assets.

The problem I see now is that fear and panic has taken over. If magically all mortgage loans went back to par, banks and other investors will still be reluctant to loan money to anyone. Even California couldn't get bids for a bond.

Supposedly, there were $1.2 trillion of subprime loans. About half are expected to default. In the grand scheme of things, this should have been a bump in the road for our financial industry. It shouldn't have required any federal funds. If something was done, it would seem that a federal "bailout" of defaulted loans would only be $600 billion.

Since all loans are now suspect, I have no idea if buying a few mortgage backed bonds will make that much of a difference. Mark to market has been "adjusted" so a lot of the distressed paper can be revalued without government intervention.

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__________________The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane -- Marcus Aurelius

Lets see you own lots of RE, so you hire a Manager, give him or her 100 days to "fix the problem", at the end of the 100 days the employment WILL terminate, and you have find "someone else". Oh yes, you give them $700,000,000,000 to work with during those 100 days. Do you really expect the "problem will be fixed"?

Hussman says Paulson plan can't work because the only way it can increase bank capital is to overpay for the loans it buys. This seems to me to follow from the simple algebra of a balance sheet.

This is not necessarily true. A bank's capital ratio is the percentage of its capital to its risk weighted assets. If a bank sells a risky asset for cash at book value its capital ratio improves. Also once it's balance sheet is cleansed of toxic assets, uncertainty is greatly diminished and private capital should return.

Hussman's alternative is known in finance as a "cram down". That is, existing investors get crammed into a more subordinate (read worse) part of the capital structure. That is almost universally viewed negatively by investors. Considering that the Government wants private capital to invest in financial institutions, Paulson likely decided that threatening to cram down current or future investors was probably counterproductive.

Yrs to go is right and Hussman example is wrong. If you have marked a sub prime security down to say $.30 on the dollar, the risk that it is worth less than .30 is considerable. The Tier 1 assets of bank is a function of the riskiness of the assets. (In general banks needs a tier 1 ratio of 6% (implying a leverage of ~16) although most banks like to see the number in the 8+%)

If a bank sells an asset to the treasury for .30 its tier 1 ratio will improve because cash has no risk associated with it. This will free up the bank to make more loans. It may even be the case that Tier 1 ratio improves even if the Treasury only pay .25 for the asset.

Haussman's example has several flaws starting this fact a bank with the balance sheet he proposed would have already been taken over by the FDIC.

__________________"Hey, for every ten dollars, that's another hour that I have to be in the work place. That's an hour of my life. And my life is a very finite thing. I have only 'x' number of hours left before I'm dead. So how do I want to use these hours of my life? Do I want to use them just spending it on more crap and more stuff, or do I want to start getting a handle on it and using my life more intelligently?"-- Joe Dominguez (1938 - 1997)

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